This blog covers financial, political and other topics the author gets the urge to write about. It does not provide personal financial, legal or other advice. Consider consulting a personal professional adviser before making any decisions. Copyright (c) 2007, 2008, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017 by Leonard W. Wang. All rights reserved.

Wednesday, October 22, 2014

Of all the potential dangers of economic inequality--slow growth, reduced upward mobility, and so on--social destabilization is the most worrisome. This is when people say, "Enough. We're not waiting for things to happen. We're making them happen. Our way."

The pro-democracy demonstrations in Hong Kong were nominally over Chinese attempts to limit the freedom of Hong Kong's elections by vetting candidates. Only pro-Beijing candidates need apply. But growing economic inequality in Hong Kong fueled the anger of the demonstrators. Wealthy Chinese are buying up prime real estate in Hong Kong, pushing prices beyond the reach of the local middle class. The wealthiest Hong Kong residents are, like the 1% elsewhere, growing disproportionately richer. Job and other opportunities for many others are looking bleaker. Middle class Hong Kong residents began to see less and less for themselves in the status quo. They didn't take things quietly.

Democracy is a mechanism by which the 99% push back against the growing wealth and power of the 1%. Without democracy, oligarchs and plutocrats flourish. China has an authoritarian government, whose powerful members and their families are intertwined with China's economic elite. The ordinary citizens of Hong Kong have no voice in the northern capital. Public protest is only way for them to be heard.

Modern day mandarins in Beijing no doubt shivered when protest banners unfurled in Hong Kong. Since the days of dynastic China, rebellions against the central government have usually ignited in southern China. Far from the seat of power, the discontented more readily questioned claims to the Mandate of Heaven. Indeed, both of the rebellions that unseated the last emperor, and then the Chinese Nationalist government (now a vestige on Taiwan), began south of the Yangtze River. In recent weeks, Communist cadres have no doubt been taking more business trips to warmer climes.

Turmoil from economic inequality is not limited to Hong Kong. In the city by the bay, middle and lower income San Franciscans have bristled at the invasion of the geeks from the Silicon Valley. Young technocrats have driven up real estate prices and Yuppified neighborhoods that heretofore took pride in their eccentricity. Charter buses used for commuting by the options-compensated have been attacked by the not-so-well compensated. The so-called trickle-down theory isn't entirely benign. Capitalism has losers, and the losers will push back.

America is a democratic nation, although increasingly dominated by Big Money as a result of U.S. Supreme Court decisions striking down various limits on campaign contributions. Democratic Party get-out-the-vote efforts in 2008 and 2012 have held the forces of wealth at bay for now. But countries tend to work best when they have a government of the people, by the people and for the people. Economic inequality cannot continue to increase indefinitely; and consequently, it won't. The only question will be how it ends. Let's hope it doesn't end badly.

Sunday, October 5, 2014

Some predict that student debt will be the next asset bubble that will make the financial markets crash. That's unlikely, but student debt is a huge and growing problem that gnaw away at economic growth until something changes.

Student debt won't bubble and burst like mortgages because the impact of losses wouldn't be centralized in the financial system. The reason why mortgages, and their kissing cousins, mortgage-backed derivatives, almost blew up the world's financial system in 2008 is that when the ship hit the sand, the impact of losses was concentrated on the largest financial institutions, in particular an insurance company called AIG. These institutions would have been rendered insolvent toute de suite, and the financial system would have been engulfed by a roaring flushing sound.

Some 20% or so of student loans are in default, and very possibly many more will never be fully repaid (for various reasons, it's sometimes possible to avoid default by paying small amounts of student loans but not be repaying fast enough ever to fully pay off the debt). The impact of these losses will be spread out over time, and much if not most of it will fall on the U.S. government. Which means that taxpayers will bear a lot of the burden, along with private investors. But it will be a diffuse, albeit large, burden rolling out over years and decades. There won't be a sharp poke in the eye at a discrete moment in time that will trigger a financial crisis.

But the aggregate amount of student debt keeps growing (it's over $1 trillion now), and the burden of repayment is growing commensurately (especially since interest rates on federal loans will float, and given today's ultra low rates, they can float only in one direction). The burden of defaults and other nonpayment will also grow. It's anecdotally said that student loans are holding up everything for many young adults--marriage, car purchases, home purchases, having children, and so on). Maybe it makes sense that the sharing economy (car sharing, bike sharing, and the various iterations of the rental economy) is booming. Young people can't afford to buy things, so they purchase the use of things for short periods of time. This may be good for the environment, but it hinders economic growth. If the burden of student loans becomes heavy enough, the impact could be lifelong, and entire lives could end partially unlived.

Student loans are almost impossible to discharge in bankruptcy. It's easy to get federal loans--you just need to be admitted to an accredited institution--so there's an understandable reason for making them hard to ditch. Otherwise, taxpayers could be asked to give free college educations to vast numbers of people. And college educations provide lifelong benefits, so it's arguably fair to ask people to repay college loans, even if it takes a lifetime.

But student debt has become a bear trap for those who default. Of course, their credit scores are knocked down. That seems fair enough, but that's also where the kidney punches start. Many employers won't hire a person with credit problems. If you are laid off and then default on your student loans, you may not be able to get a new job to repay them. Sometimes, you lose a professional license (like a nurse's license), which makes it even more difficult to find a job to repay the loan. Defaulted loans continue to bear interest and penalties are imposed for default, thus ballooning the amount you have to repay. So, if you have significant student debt, here's what you have to do: (a) never lose a job; (b) never get so sick that you have to take major time off from work; (c) tell your aging parents that you can't help support them in their old age; (d) tell your spouse he or she can never lose a job, get so sick that they have to take major time off from work, and provide no support to their aging parents; and (e) never do anything that would otherwise result in default. Getting to like rice and beans, network television broadcast to a TV with rabbit ears, and knitting your own socks, would also be good.

What will happen is, eventually, substantial relief will be given by Congress to student loan defaulters. The exact scope and terms of the relief aren't easily predicted. But it will happen. Why? Because the problem has become too big, and full repayment is increasingly unlikely for too many borrowers. Since students from middle and lower income classes are the most likely to take out loans, the burdens are distributed in a regressive way. Sooner or later, that will find expression in the ballot box. When too many people labor under the burden of student loans, their combined political voices will overwhelm the lobbyists and influence peddlers employed by the student loan industry and the educational institutions that free-ride on easy educational credit.

There's a precedent for allowing student loans to be discharged in bankruptcy--that's bankruptcy itself. When Lord Cornwallis' Redcoats surrendered at Yorktown in 1781, there was no such thing as bankruptcy. Debtors were not only expected to repay their debts in full, but could be imprisoned until they did so. As one might expect, the use of debtors prisons wasn't always fruitful. A debtor in prison couldn't work or otherwise do much to repay. But debtors were commonly imprisoned in the belief that the world was a better place for it.

However, as America grew into a bustling, vibrant industrial nation, voices of reform argued for giving debtors a chance for a fresh start. Freed from old debt, individuals could more fully participate in the economy and provide for their families, thus strengthening future generations. Creditors pushed backed, contending that a man's word should be his bond and that shiftless, lazy and prevaricating deadbeats shouldn't be able to hoodwink those that extended credit in good faith. But the voices of reform won the debate, and America became one of the early adopters of the concept of bankruptcy.

Permitting bankruptcy shifts risks, placing more of the burden of default on creditors and less on borrowers. As a consequence, market forces led creditors to adjust their practices, raising interest rates on all borrowers and eventually adopting the credit scoring system. In effect, all borrowers pay for the defaults of some, but all borrowers have the option of bankruptcy. Since you never know when life may blow up in your face, this may not be so bad.

The student loan crisis will eventually impel something similar. The sheer, growing size of the problem will force change. Student loans increasingly are no longer just the problem of some, but the problem of many, most and perhaps even all. Of course, if student loans become dischargeable in bankruptcy, other changes will result. Interest rates on the loans would likely increase, so that all borrowers cover the costs of defaults. And educational institutions may be required to pay a portion of defaulted loans--at least for those students who don't graduate, so that colleges don't accept applicants who are unlikely to graduate and then free ride off the loan revenues from those students. These changes would be appropriate, since taxpayers shouldn't have to fund handouts for the educational sector.

The current student loan crisis is yet another illustration of the problems of easy credit. Easy credit at first seems like a bargain, and everyone loves it. But there's no free lunch, and the costs of easy credit will eventually emerge. When the problem becomes so severe that it cannot continue in the present form, then it will change.

Please read

My zany novel about crime and punishment on Wall Street. RATED 5 STARS ON AMAZON. Please click on the image for a description of the book and a list of websites where it is available.

Tale of the Magic Dragon

Betrayal. The Vietnam War was full of betrayals. And they didn't stop when the war ended. MIA's don't return alive--or do they? My novel, about things that never officially happened. Click on the image for a list of booksellers. RATED 5 STARS.